Arista Networks, Inc.

Welcome to the first quarter 2020 Arista Network's financial results earnings conference call. During the call, all participants will be in a listen-only mode. After the presentation, we will conduct a question and answer session. Instructions will be provided at that time. If at any time during the conference you need to reach an operator, please press star followed by zero. As a reminder, this conference is being recorded and will be available for replay from the investor relations section at the Arista website following this call. I will now turn the call over to Mr. Curtis McKee, Director of Corporate and Investor Development. Sir, you may begin.

Curtis McKee Thank you, operator. Good afternoon, everyone, and thank you for joining us. With me on today's call are Jay Shriyalal, Arista Network's President and Chief Executive Officer, and Ida Brennan, Arista's Chief Financial Officer. This afternoon, Arista Networks issued a press release announcing the results for its fiscal first quarter ending March 31, 2020. If you would like a copy of the release, you can access it online at our website. During the course of this conference call, Arista Networks Management will make forward-looking statements, including those relating to our financial outlook for the second quarter of the 2020 fiscal year, longer-term financial outlooks, the potential impact of COVID-19 on our business, industry innovation, our market opportunity, the benefits of recent acquisitions and the impact of litigation, which are subject to the risks and uncertainties that we discuss in detail in our documents filed with the SEC, specifically in our most recent Form 10-Q and Form 10-K, and which could cause actual results to differ materially from those anticipated by these statements. These forward-looking statements apply as of today and you should not rely on them as representing our views in the future. We undertake no obligation to update these statements after this call. Also, please note that certain financial measures we use on this call are expressed on a non-GAAP basis and have been adjusted to exclude certain charges. We have provided reconciliations of these non-GAAP financial measures to GAAP financial measures in our earnings press release. With that, I'll turn the call over to Jay Shree.

Thank you, Curtis. Thank you, everyone, for joining us this afternoon for our first quarter 2020 earnings call. First, I would like to address the coronavirus global pandemic, the world's largest in 100 years. Clearly, this is unlike recessionary events including the dot-com crash of 2001 or the financial recession of 2008, both of which were sector-specific. At Arista, we are focused on the welfare of our employees, supporting our customers, and helping the local community. We recognize our role and responsibility in supporting global communications and cloud infrastructure during these mission-critical times. We're adjusting to the new norm of real-time audio and video communications. Our support caseload has doubled during the initial weeks, but has now stabilized as we help our customers in their time of need. Getting back to Q1 specifics, we delivered revenues of $523 million for the quarter, with a non-GAAP earnings per share of $2.02. Service contributed approximately 21% of revenue, up from 19% last quarter. Our non-GAAP gross margins were 65.6%, influenced by a healthy software and services mix. We registered a solid number of million-dollar customers as a direct result of our enterprise traction. In Q1 2020, Cloud Titans was our largest vertical. The enterprise is now consistently the second largest, followed by the Tier 2 specialty cloud providers, and financials tied for third place, and the service provider at fourth place. Due to popular requests from our analyst friends, we are now providing more color into our annual trends across three main sectors. Cloud titans, approximately 40% of our mix, enterprise, including financial services, approximately 35% of our mix, and providers, which includes both service provider and cloud specialty provider, approximately 25% of our mix. In terms of geographies, Q1 2020 mix had international contribution at 23%, with the Americas at 77%. In terms of mergers and acquisitions, we closed the acquisition of big switch networks in February 2020. We are experiencing early traction and complementarity with Arista's data analyzer, DANS, offering and entering into the network packet broker space. We are extending in the campus our cloud networking principles, introducing exciting cognitive Wi-Fi suite of features with the support of Google Hangouts, Microsoft Teams, and Zoom, as well as open config-based automation model. Arista's cognitive campus portfolio was launched last summer to address the explosion of clients, users, and IoT devices with software-driven automation. We are well on our way to meeting our first year's 100 million target, ending Q2 2020. While we are pleased with this traction, we must all exercise patience as we cultivate this part of our business. It took us more than seven years to build our cloud business to 500 million, and we believe that our enterprise prospects will take time, especially in this COVID-19 era. We are only just beginning our first year of a five to seven year journey to disrupt 30 years of legacy and status quo. COVID-19 has required us to respond rapidly to changing events. In accordance with the country-specific shelters and orders, we have closed all our offices to assure employee health and safety. We are consequently experiencing supply chain constraints, and we are managing our global capacity with our contract manufacturers in San Jose, Mexico, Malaysia, and coping with some inventory and component shortages. Lead times vary and have doubled recently for some of our popular products. Arista is working in lockstep with our customers in supporting their business continuity and planning throughout 2020. Our visibility, especially into second half 2020, is pretty low. The number of confirmed COVID-19 cases has increased sharply in April. Until the economic environment permits us to resume more normal routines, we have limited visibility to demand. It is clear that we live in uncertain times, and therefore with what we know at this time, it is prudent to assume our annual 2020 revenue may decline versus our 2019. We expect to manage our overall business this year at Arista's 2018 levels, and we'll continue to monitor this closely. Arista, together with the entire business sector and global supply chain, is coping with multiple unknowns in the midst of a global pandemic. We expect to see some short-term strength in Cloud Titan offset by prolonged sales cycles with new prospects in the campus and enterprise sector. We remain confident that the combination of our product superiority, commitment to quality, with the lowest critical vulnerabilities, and the highest net promoter score of 76 is very compelling in the network industry and of great value to our customers. Our recent market share gains, customer intimacy, and operating leverage will navigate us through these unforeseen circumstances. We expect to emerge stronger than many of our industry peers as we migrate to modern networking. Before I turn it over to Ida for financial specifics, on behalf of Arista, I truly wish all of our listeners, employees, and their families, customers, and well-wishers be safe and healthy. Ida?

Thanks, Jayshree, and good afternoon. This analysis of our Q1 results and our guidance for Q2-20 is based on non-GAAP and excludes all non-cash stock-based compensation impacts, certain acquisition-related charges, and other non-recurring items. Full reconciliation of our selected GAAP to non-GAAP results is provided in our earnings release. Total revenues in Q1 were $523 million, down 12% year-over-year, and just above the lower end of our guidance of $522 to $532 million. As discussed previously, this decline on a year-over-year basis was in part related to the recognition of approximately $83 million of deferred revenue in the first quarter of 2019. In addition, while demand in Q1 2020 was reasonably healthy, we did experience some COVID-19-related component supply and manufacturing challenges, which resulted in extended lead times and somewhat constrained shipments for the quarter. Service revenues represented approximately 21% of total revenue, up from 19% last quarter, reflecting strong service renewal activity in the period, coupled with a lower product revenue number. International revenues for the quarter came in at $122.4 million, or 23.5% of total revenue, down from 25% in Q4. Shifts in geographical mix on a quarter-over-quarter and year-over-year basis were largely driven by the level of revenue and the location of deployments by our Cloud Titan customers. Overall gross margin in Q1 was 65.6%, well above our guidance of approximately 63%, and up from 65.2% last quarter. As expected, we saw strength in our Cloud business in the period, with a related lower gross margin impact more than offset by some one-time constrained supply-related sales of previously reserved inventory and a healthy mix of software and services mix. Operating expenses for the quarter were $149.3 million, or 28.5% of revenue, down from last quarter to $154.3 million. R&D spending came in at $91 million, or 17.4% of revenue, down from $96.2 million last quarter. This decline largely reflected lower engineering and prototype costs in the period. Sales and marketing expenses was consistent with last quarter at approximately $46 million or 8.8% of revenue, with increased headcount costs somewhat offset by lower marketing and travel-related spending. Our G&A costs were flat to last quarter at approximately $12 million, or 2.3% of revenue. Our operating income for the quarter was $194 million, or 37.1% of revenue. Other income expense for the quarter was a favorable $12.2 million, and our effective tax rate was approximately 21.6%. This results in net income for the quarter of $161.7 million, or 30.9% of revenue. Our diluted share number was 79.94 million shares, resulting in a diluted earnings per share number for the quarter of $2.02, down 12.6% from the prior year. We completed the purchase accounting for Big Switch acquisition in the period, with immaterial amounts of revenue and expense included in our non-GAAP results in the first quarter. For those of you focused on our GAAP results, we recorded $11.9 million of acquisition-related expenses in the period, which we consider to be one time in nature, and which together with $4.9 million of amortization of acquired intangibles have been excluded from our non-GAAP results. A full reconciliation of our GAAP to non-GAAP results has been provided in our earnings release. Now turning to the balance sheet, cash, cash equivalents, and investments entered the quarter at approximately $2.6 billion. We repurchased $228 million of our common stock during the quarter at a weighted average price of $189 per share. This brings our total repurchases to date to $494 million, or 2.4 million shares over a four-quarter period. As a reminder, our Board of Directors has authorized a three-year, $1 billion stock repurchase program commencing in Q2 2019. The program allows us to repurchase shares of our common stock opportunistically and is funded from operating cash flows. We generated $195 million of cash from operations in the first quarter, affecting solid net income performance and a slight increase in working capital requirements. DSOs came in at 61 days, down from 65 days in Q4, affecting the timing of billings in the period. Inventory turns were 2.5 times, down from 2.9 last quarter. Inventory increased to $262 million in the quarter, up from $244 million in the prior period. Our total deferred revenue balance was $597 million, up from $575 million in Q4. As a reminder, our deferred revenue balance is now almost exclusively services-related. Accounts payable days were 43 days, down from 44 days in Q4, reflecting the timing of inventory receipts and payments. Capital expenditure for the quarter was $3.1 million. Now turning to our outlook for the second quarter and beyond. As Jayshree mentioned, we continue to closely monitor the impact of COVID-19 around the world. We, our customers, and our supply chain partners continue to operate under various local restrictions, and it is unclear when and how these restrictions will be lifted. While we're not in a position to predict these outcomes and provide longer-term guidance, we did want to provide some color on how we are managing and framing the business in the interim. While we expect demand from our cloud businesses to remain stable, we believe a number of other verticals could see some pause or slowing of IT spending, pending clarity on the economic outlook. Given this uncertainty, we believe it prudent to manage investments carefully and in a range closer to 2018 levels. We are prioritizing key projects and customer engagements while benefiting from a natural reduction in travel, marketing, and other variable expenses. On the gross margin front, we would reiterate our overall gross margin outlook of 63% to 65%, with customer mix being the key driver. Now for a couple of additional housekeeping items. We have continued to see some upward pressure on the effective tax rate and have increased the forecasted rate to 21.8%. In addition, we expect the current lower interest rate environment to negatively impact our other income amounts in the future. Finally, our guidance for Q2 reflects our current understanding of COVID-19 and its impact on our business and supply chain. This is, however, an inherently uncertain situation, and we will need to continue to monitor and attempt to mitigate new challenges as the situation unfolds. With all of this as a backdrop, our guidance for the second quarter, which is based on non-GAAP results and excludes any non-cash stock-based compensation impacts, and other non-recurring items is as follows. Revenues of approximately 520 to 540 million, gross margin of 63 to 65%, operating margins of approximately 35%. Our effective tax rate is expected to be approximately 21.8%, with diluted shares of approximately 79.7 million shares. I will now turn the call back to Curtis.

Thank you, Ida. We are now going to move to the Q&A portion of the Arista earnings call. Due to time constraints, I'd like to request that everyone please limit themselves to a single question if possible. Thank you for your understanding. Operator, please take it away.

We will now begin the Q&A portion of the Arista earnings call. In order to ask a question during this time, simply press star, then the number one on your telephone keypad. If you'd like to withdraw your question, press the pound key. We ask that you pick up your handset before asking questions in order to ensure optimal sound quality. Your first question comes from the line of Sameek Chatterjee with JPMorgan. Your line is open.

Hi. Thanks for taking the question. You mentioned the short-term benefit you're expecting from some of the cloud companies. So maybe if you can elaborate on that a bit, how much of this is from the cloud titans? What are you seeing from the specialty cloud providers? Are you expecting similar upside there? And why isn't there more confidence in the sustainability of this kind of upside as we look a bit more longer term? Thank you.

Sure. Thanks, Amik. Well, as you know, Aristo's cloud-tightened performance is consistent with the Cloud CapEx reporting. In other words, some are experiencing strong spend, some are declining, and others are cautious. So given all the pluses and minuses, I think it's safe to say that for the year, we expect a flattish Cloud Titan trend. And this is actually an improvement because we've been saying flatter down. So of course, we'll monitor this closely. As you know, we never have long-term visibility on Cloud Titans. It's quarter by quarter. So we'll inspect more closely, especially for the second half. Now, in terms of the Cloud specialty providers, they were actually a stronger trend for us in Q1. It's pretty cyclical in nature and depends on different tier two cloud providers. Each one has a unique architecture. We had a somewhat weak specialty cloud providers in 2019, but they've started off well for us in Q1 and Q2. And over time, it'll be a matter of economics and what makes most business sense for them. I believe some of them will succeed in specialized use cases, but once again, we're gonna keep a watch and monitor this closely in the second half.

Thank you. Your next question comes from Tim Long with Barclays. Your line is open.

Jayshree, I was hoping you could talk a little bit about the enterprise vertical and maybe on two different vectors if you can just kind of give us a little color on what you're seeing on large enterprises and then as it relates to you talked about a longer process for you know, the campus move. Could you just talk a little bit about the moving parts near term, given that obviously, you know, a lot of people are working from home, so it's difficult to sell on-prem equipment. So if you could just give us a little more color there. Thank you.

Yeah, sure, Tim. So to answer your broad question on enterprise sector, I think Arista's brand is very well recognized for data center. And, you know, with our 6,000-plus customers, we've got very good recognition there from a differentiated product And we've already been very engaged with them. So customers we've been engaged with, in fact, we had most recently in February, just a little before all the doors got shut down on us, we were engaged with over 100, 150 enterprise customers. And we had a global advisory and a risk to innovate. So our intimacy with enterprise customers is very high. And we continue to do well with them with both existing and new projects. I think where we will be challenged in the enterprise and also in the campus is new prospects. We're not gonna get enough face time with them. We're doing a lot of virtual webinars, virtual events, virtual EBCs. It's a virtual world we're certainly living in. But the level of contact for both product capability, conversation, relationship, partnership, and in fact even testing for both new prospects in enterprise and campus will be challenging. And nobody's in the building to upgrade their campus either. So the COVID-19 will definitely delay our enterprise cycles for new prospects, but should be okay for new projects with familiar customers.

Okay, thank you.

Thanks, Tim.

Your next question comes from Alex Kurtz with the KeyBank Capital Market. Your line is open.

Yeah, thanks, and I'm glad everyone is listening. safe and healthy over at Arista. I just wanted to follow up, Jayshree, on your commentary from the beginning of the call. You said you're planning to run the business versus 2018 levels. I assume that's an OpEx comment or is that an OpEx comment that also maybe relates to where you think revenue could kind of pencil out at the end of the year?

Alex, first of all, I think we understand the first half better than the second half. Please take this with a a grain of unknown and uncertainty in everything. And I know CEOs are supposed to know everything, but I can honestly tell you we don't know much about the second half. So what we're doing is controlling what we can control. And what Ida and I can control is the business and the expense more than the top line for the year. And Ida, you want to add more to that?

Yeah, I mean, I think, Alex, it's a focus on just OPEX and investment levels until we understand better kind of what the rest of the year, how the rest of the year plays out, right? And so, you know, you should expect to see us kind of cut back on some of the variable expenses, et cetera, and, you know, come back to spending that looks similar to where we were for 2018. And then as things unfold, we can we can change that, right? But for now, that's the focus.

And Ida and I want to reiterate something. We will absolutely continue pedal to the metal, invest in key R&D and customer support. We will reduce marketing travel, obviously, since we can't travel, and perhaps some IT spending. And so we work on what we can control and manage the business, and if it improves, we'll certainly recalibrate and invest more.

I appreciate that. And, Ida, just on the 40% comment on CloudTitan mix year-to-date, obviously, it would be helpful to have the year-over-year comp if you're willing to give that.

Yes, I think in the investor deck, we've put some trends around what the split has been and how it's looked, and we put a range in there for kind of how it played out during the during the year, right? During the past year, right? So the investor deck is looking at a trend over the prior year, and then Jayshree's commentary is more short-term. So I think that gives you a range to work with.

Thank you. And we put a special slide for you guys, slide 15, I think it is, Curtis, right?

Right, right.

That's in your honor.

I appreciate that. Thank you.

Your next question comes from Jason Adder with William Blair. Your line is open.

Yeah, hi. Just really two quick ones. I promise they're going to be very quick. Number one, is it correct that cloud outperformed in Q1 versus expectations in enterprise underperformed? And then secondly, Jayshree, can you comment on your campus timeline of the 100 million? Is that pushed out now?

Okay, Jason. I think both cloud and enterprise performed as we expected in Q1. If there was a theme in Q1 which becomes a stronger theme in Q2, I would say supply constraints and supply chain. Our verticals were pretty normal as expected. In terms of campus timelines, we are on target. We're committed to 100 million revenue in the first four quarters that ends Q2 2020. No change there. But we do expect that the acceleration I would have personally liked to see beyond that in the second and third year, we now have to wait and see due to COVID.

Thank you. Thank you, Jason. This question comes from Itai Kidron with Oppenheimer. Your line is open.

Thanks. Hello, ladies. Congrats. And I must say you're very brave to offer a second quarter guidance, so I hope it works out. Let me see. A couple of questions for me. First of all, on the supply chain, can you tell us how much revenue spilled over from 1Q into 2Q because of that so we can understand the true run rate of your business in 2Q? And, again, going back to Alex's question on the 2018 investment levels, Ita, just to fine-tune this, does that mean total OPEX, 2020 equals total OPEX in 18, or is this a run rate comment? I just want to make sure I appropriately captured that modeling-wise.

Yeah, I mean, I think as we sit here today, we would say we're managing it to an overall, you know, plus or minus 2018 total OPEX number, right? And again, obviously, as we know more, Itai, as we go through the year, we'll continue to address that further. But for now, that's how we're seeing it.

And as far as the push-out?

Yeah, so to answer that question, Itai, we did our best in Q1, but we got supply constrained in March. I think we will be really supply constrained in Q2. So I do think Q2 is a case of less about demand and more about supply constraints.

Thank you, Itai.

Your next question comes from Simon Leopold with Raymond James. Your line is open.

Thank you. Appreciate the opportunity. I wanted to sort of visit the question or comment you made regarding the COVID crisis, making it more challenging to sell new products. I guess what I'm looking for is a better understanding of how much of your business comes from new customers slash new products. And I certainly appreciate you've got 400 gig products in the pipeline, campus in the pipeline. But I guess what I'm struggling with is the sense that a lot of the campus was targeting existing customers. So just trying to understand that comment and how to quantify how that fits into the overall guidance. Thank you.

Yeah. Thanks, Simon. First of all, it's important to understand that a $100 million campus target is $100 million. It's small compared to our overall business. We do believe that we can naturally go into our existing customers who already know EOS and Cloud Vision. But as I said last year, we were pleasantly surprised by the new prospects and interest in campus. So in a non-COVID environment, I would have expected 60% existing customers and 40% new prospects. In the current environment, I think we're gonna go back to a comfort level where familiar customers are more likely to spend with us and our new prospects will take time. So it'll probably be 70%, maybe even higher, on familiar and existing customers in 2020, which was not the trend we were on before last year.

And the implications for 400 gig, has that slid out as well?

No, okay, so I was answering your campus question. What was your question on 400 gig again?

Well, I guess broadly speaking, I think of new, including campus, and 400 gig. So I just want to get a sense of how you see the timing of the 400 gig market, if that has slid out versus your prior expectation, and if so, when?

Okay, so first of all, 400 gig we believe is truly for our high-end enterprises, service providers, cloud, and very, very high-end enterprise, quite the opposite of campus. And as we said before, we expect early 400 gig trials will be in the late 2020 timeframe, and actually material production, general availability due to low-cost lack of cost-effective 400 gig optics, and even some of the COVID issues will be in 2021. Nothing's really changed there, but we continue to see that. Now, we did have some exciting product announcements. In 400 gig, we introduced the Arista OSFP line card, which is really a low-power, highly compact, pluggable OSFP form factor. for simplifying DWDM for distances up to 120 kilometers. We also demonstrated interoperability with Ciena with their most dense and spectrally efficient 400 gig and Arista switch. So our 400 gig trials definitely are continuing with existing customers and cloud titans. But as we've always said, we expect, just to put this in context for you, in Q4, The number of 400 gig ports, according to market researchers, is 5,000 ports. However, the 100 gig ports was several million. So there's a 1,000x magnitude difference between the two, and I don't think that's going to change in the near term.

Thank you for taking the question, sir.

Absolutely. Your next question comes from Jeff Cole with Nomura InstantNet. Your line is open.

Yes, thank you. I was wondering if you could help us understand the nature of the demand change over the course of the quarter and into April, just so that we get a little better sense of how you are thinking about the second quarter developing. Is it going to end strongly or is it improving through the quarter? That type of thing.

Okay. So I think we have yet to experience the full impact of COVID-19. I think we'll see much more of that in the second half. So if I look at Q1, we experienced it at the tail end, mostly in terms of our supply chain. And if I look at Q2, we'll still be very supply chain constrained. So I think we understand Q1 and Q2 better, and both of them were, you know, Q1, as you know, is seasonably slow quarter for us. It really picks up steam in March, and we couldn't pick up enough steam because we couldn't ship enough. And that steam is going to continue into Q2. So Q2 is all about shipments. We do see, as we said, good strength in the cloud titans. And we see reasonable demand in Q2, but I think our real worry is second half.

Okay. Are you able to share with us a loose dollar range for how much the supply constraints do you think are affecting you in either the first or the second quarter?

Well, I think the first quarter is done, but you can tell we projected lower than consensus. You can count all of that and more as supply chain related.

Yeah, I mean, I think, Jeff, if you look at where we came out for the first quarter on revenue versus our guide and stuff, it gives you some idea of the magnitude of that, right? I'm not going to try to do that for Q2 at this stage. Yeah.

Okay. Thank you both very much.

Thank you. Question comes from Aaron Rakers with Wells Fargo. Your line is open.

Thanks for taking the question. Kind of a different way of maybe asking the same question again. But, you know, I'm curious of how you think about the demand profile from the cloud guys. We're seeing, you know, industry reports talking about pretty healthy server demand at several of these public cloud vendors. We've seen the numbers from Microsoft and others. And what kind of the lag effect you see between server footprint deployments or expansion versus actually pulling more network bandwidth needs, and obviously a benefit for Arista.

First of all, we do see Cloud Titan use case demand in basically three areas. Either our customers are adding additional core or spine capability, or they're expanding racks to increase their server density, or in some cases, we're also seeing some geo-expansion for their international needs, although some of them have been ordered from the United States, increasing our U.S. Titan core. contribution. So I think the use cases for us is very, very clear. What we also see is that because we have long lead times that Anshul and the team are working very closely on really understanding and sharpening their forecast and timing and working with us on scenarios and contingencies. So I think when they're starting to look at their 2020 deployments, they're not just looking at Q1, Q2. They're trying to give us visibility for the second half as well. And so while we have not factored any of that into our Q1 or Q2 forecast, we are seeing them doing some very prudent planning for business continuity in their 2020 timeframe.

And if I heard you, I'm sorry.

Sorry, go ahead. Anshul, would you like to add some more to that?

Yeah, absolutely. I know there's been a lot of commentary about other components that go into the cloud, whether it's compute, other pieces, and so on. And it's hard to correlate one for one, especially in this time frame. Because some of the spike in those other components is coming because of shortages in previous quarters, if you remember that. As a result of that, there might be some volatility and you'll see some spike up on compute and so on. Networking has been stable. As Jesse mentioned, we saw constraints towards the end of Q1. But prior to that, things were stable. So they were not short on networking gear and so on. I do want to add one last comment on the traffic needs. And there's a lot of commentary on the street on how traffic is growing and spiking up and work from home and so on. We have to keep those trends in mind relative to the overall cloud capacity. And yes, working from home means you may need video conferencing or phone calls or type edge connectivity. But that's a very small fraction of the overall cloud spend in the broader markets. So yes, sometimes traffic quadrupled or grew 7x in certain regions, but that's less than a 1% impact of the overall spend. So I would say there's some hype around that rather than material impact to us. But as everyone mentioned, things in the cloud are stable. And now we'll focus on the second half with them.

That's a great answer. Stable meaning you expect the full year to be stable for cloud versus previously saying it would be meaningfully down. Yeah.

Like we said, Aaron, we said we expect the cloud to be flat year over year.

And just to clarify before we get all wrapped on the revenue deferred thing again, when we're talking about this commentary is around the business and the trends of the business, and then obviously we still have to deal with the deferred after that, right? But it is an improvement from, we had talked about the business being flat to down, and now we're saying we think it's stable in that context, and then the deferred is additive to that afterwards, right?

Thank you very much. Thanks, Erin.

Thanks, Erin. Thank you, Erin. Your next question comes from Ryan Kuntz with Rosenblatt Securities. Your line is open.

Great. Thanks. I'd like to ask about the service provider segment. It's been somewhat of a laggard. Are there any kind of new strategies or products that you guys are rolling out, or is there a different sales motion that you think is going to invigorate that segment? Thank you.

Yeah, no, thank you for that. We have been marching towards more and more product capability. In fact, we just introduced EOS software release 4.20.4, very targeted towards cloud-grade routing and service provider peering use cases with a single EVPN control plane and segment routing and MPLS on the data plane, just a chock full of features, BGP, flow-aware transport label, MPLS, segment routing, traffic engineering. What I can tell you is they're getting richer and richer in our product capability, but what I can also tell you is service providers take time to operationalize these things in their network. We are doing okay in our already existing service provider customers, and we are starting to win some small Tier 2 and Tier 3 ones, small ones, but too early to call and too early to say much more about it.

Great. Thanks, Jayshree.

Thank you, Ryan. Thanks, Ryan. Your next question comes from Eric with JMP. Your line is open.

Yeah, thanks for taking the question. Can you just discuss how the large enterprise accounts are getting impacted by COVID-19? Is it a sales execution issue where calling on the customer is the challenge, or is it actually a personnel issue where they've got people staying at home and not in the data centers deploying servers and switches, or Where is the disruption most impacting?

So, Eric, I would classify it in two ways. I think the large enterprises that are already intimate with Arista and need to make incremental enhancements, we're okay. They're familiar with us. They know how to work with us. We're supporting them. Our systems engineering team is led by Ashwin. Our sales team is led by Krishmit. have tremendous amount of engagement with our existing customers. So I don't see a dramatic change yet in sales engagement or product differentiation. Where I do see difficulty is prospects. So we're having a tremendous amount, we have been having a tremendous amount of new customer logos. And our new customer logos continue to be healthy. And we gather steam, especially internationally, where 60% of our new customer logos come in. However, to convert them, especially into large deals and large enterprises, requires large proof of concept, number of network design clinics, and obviously we're slowed down due to the lack of face-to-face. So we're spending more time with them training, educating, than we are able to do in deployment. Whereas with our own existing familiar enterprise customers, we can march forward with more progress.

Okay. That's very helpful. Thank you.

Thanks, Eric. Our next question comes from Mita Marshall with Morgan Stanley. Your line is open. Great. Thanks.

Maybe just one for me. You know, you noted kind of strong behavior out of some of the Tier 2 clouds, but, you know, has there been any change in thought or is it just too early of, you know, as the tier twos go forward, whether they will continue to kind of build their own data centers or leverage the public cloud more? Do you expect kind of this to have any change to that behavior? Thanks.

Mehta, that's a good question. You know, and I said before, it depends on the tier two. We know some of the larger tier twos have paused, and it's not that they're going to the public cloud, but they're just pausing their spending. Others are expanding their data centers, and some of the smaller ones are continuing to for their specialized applications. So it's my belief that they will continue to succeed in their special use cases and complement the public cloud. But it'll be cyclical. They didn't do much of it last year, and I think some of them are coming back this year. And what we are seeing is the specialty clouds are realizing that some of the workloads they can control better, and some belong in the public cloud. So I think they'll continue to have a place. And in fact, a good example of that was the content delivery network guys. We saw improved traction with the CDN customers, and there's some real-time streaming and content delivery, particularly with work from home. With the millions of users and the aggregates of 4K and 8K flows, you can see why they would make some important investments there.

Got it. Thank you. Thanks, Meeta. Your next question comes from Pierre Fergu with New Street. Your line is open.

Hey, thank you for taking my question. One more on cloud. So on this perspective that you'll have flat revenues between this year and last year, I was wondering how your mix is going to – you see your mix evolving. And a couple of things I have in mind is, you know, what you sell at the lower end of the hierarchy in access, server access, at the least level versus things you sell – higher for DCI, for the universal spine, or maybe another way to look at the split would be Tomahawk-based products versus Jericho-based products. Do you see a significant evolution in that mix between this year and last year? Thank you.

Thank you, Pierre. I would say a short answer is no. We've always had a very nice mix of value products with the Tomahawk and Trident families, connecting to servers, sorry, the volume products. And then the value products with the Jericho family with the 7280 and 7500 flagship. So depending on the use cases, customers opt for both. They're both very, very popular products, and both are currently challenged with lead times as well. It's not so much that we're seeing a change in product mix. I would say the biggest change we're seeing is people are doubling down on 100 gig, and 400 gig is getting pushed out next year in the cloud. That's probably the biggest shift.

Thank you. Thank you, Pierre.

Thank you. Your next question comes from John Marchetti with Stifel. Your line is open.

Thanks very much. I'm curious with the supply constraints that are going on right now, if it impacts any one of the verticals a little bit more than any of the others, or it's broad enough that it's kind of having an even impact across the group. And then, Ida, just sort of as a follow-up to that, you sold a bit out of inventory, I'm guessing because you couldn't bring some other stuff in. Is that something that likely occurs again here in the second quarter?

Yeah, maybe let me take that first. I mean, that's a one-time thing where, you know, when things are constrained, you know, it's a good opportunity to go look at what you have in inventory and see. and sell some stuff that maybe we hadn't thought we would, but I think we're through most of that now. So that's why I think the guide for gross margin comes back to the typical, you know, 63 to 65, and then it'll just be driven more by customer mix than anything else, right?

Yeah, and John, to answer your question on our extended lead time, I'm not sure we saw a trend on verticals. What we did see is that our key customers worked very closely with Anshul and Chris and Ashwin to really sharpen their forecast and timing and work closely with us on their network designs and what products are available, what's not, when can we ship what to them. I hope these are famous last words, but I hope we can, John McCool and Christophe and the team are really working hard to overcome this. And should we improve this in Q3, I think we will have a chance to fulfill a lot of our key customers' needs and factor that into their 2020 deployment considerations. But I didn't see anything by vertical. I saw it more by top customers.

Thank you. Thank you, John. Question comes from Sammy Badry with Credit Suisse. Your line is open.

Hi, thank you. I was a little bit curious if you could give us a little bit more of maybe an idea on dynamics or just maybe some observations you've had in 1Q 2020, what's going on in Europe. And are you competing against different companies or are they offering different types of products, at least in the European region, versus what Arista has to offer? And I know you've made comments that a lot of your customers in the U.S. want to take you on also in Europe, but have you seen dynamics change either pre- or post-COVID or at least anything going on in 2020 that you could shed light on as an observation?

I think for Arista, because our presence internationally is somewhat new, we are – feeling stronger in terms of our investment in sales and different countries. So country by country, we feel better about Europe now than we did, say, even a year or two ago. What I think is the difference between Europe and the United States is they don't have the equivalent of cloud titans, and we haven't won major service provider titans. So we tend to have smaller wins, but many customers. But country by country, the level of engagement, in fact, Our entire executive team was at a Europe customer session, was it last November? We were all there, it seems like forever, but it wasn't that long ago. And the level of intimacy that the team has developed with our customers, especially in the developed countries, Germany, UK, France, Middle East, even Israel, has been very strong. So I think the European customer base is embracing Arista for its differentiation and value add. But we just don't have the size of customers we do in the U.S.

Got it. And just maybe competitors, are competitors a little bit different in Europe, or are you seeing similar competitors in both regions?

Similar, similar. We don't see a huge difference, at least not in Europe. In Asia, we tend to see some, but not in Europe.

Got it. Thank you.

question coming from Amit Daryani with Evercore. Your line is open.

Thanks for taking my question, guys. Could you perhaps elaborate on what specific... Amit, we can't hear you.

You're choppy. We lost you. We lost the entire line.

No voice. What specific supply chain issues or bottlenecks that you were dealing with And if you did not have these supply chain issues in theory, what would the June quarter guide have looked like? Would it be towards a high end or something different?

Well, it's difficult to speculate since we have supply chain issues. But, you know, the reality is different than the theory. Okay.

Yeah, I think, you know, obviously there are constraints, right? But I don't know that we can size those at this point, right? There's a lot of moving pieces.

It doesn't matter. It really doesn't matter because we have constraints.

You know, I guess I was more trying to think, could this help you and maybe size how much it could help you in the back half of the year when these supply chain bottom legs alleviate and lead times normalize? But maybe another way, I guess, if you could help us, is there a gross margin impact you're dealing with because these supply chain constraints? Is there a way to quantify that in the first half of the year? Thank you.

I mean, we saw a little bit of incremental spending in Q1, but it was very small. We will see some in Q2, but again, I think it's manageable at this stage, right? You know, again, I'd go back to the 63 to 65 and, you know, we'll be, you know, the midpoint of that range is a good place to start and then we'll see how we go. So, there is some incremental, you know, cost because you are, you know, you're prioritizing supply over some other things, but it's at least in the first half, we don't see something that's really significant.

Thank you.

Thanks, Amit.

Thanks, Amit.

Your next question comes from Alex Henderson with Needham. Your line is open.

Thank you very much. Jayshree, I was hoping you could give us some insight into the way enterprise executives are thinking about conditions, what they're thinking about in terms of how they're approaching spending you made a comment that i think is probably accurate which is you're more concerned about covet in the back half and i assume that's not supply chain related it's more demand related and i would assume that you've done a lot of calls with top executives at firms what are they saying to you about the business in process the you know the programs that are already in place are getting completed but you know, maybe the pipeline's falling off as you exit the, you know, second quarter, and that their expectations for spending in the back half may be, hard to put it any other way, sharply constrained.

Right. So, Alex, that's a good question. I think our enterprise decision makers and key executives are struggling with this once-in-100-year phenomenon just the way we are, right? They all do have 2020 plans and deadlines, and they would very much like to work with Arista and overcome the supply constraints to meet them. And I believe they will. I believe they'll also take, many of them will also take not just a 2020 horizon, but a multi-year horizon and start thinking about how to plan for projects in this virtual world. So we do see some systematic, prudent planning. And while we don't have visibility to that demand, we don't think Demand will be challenged significantly if they plan prudently. Where we think demand will be challenged, like I said before, is new projects. People unfamiliar with Arista, people who have to do a lot more testing with Arista, people who love Arista but haven't had a chance yet to get their hands on it. So that class of enterprise customers may be more comfortable with doing nothing or being as is. But certainly the 6,000 plus customers we engage with really, really want to work with us. and will continue to plan their projects this year or next year.

Great. Thank you very much.

Thank you. Your next question comes from Paul Silverstein with Cohen. Your line is open.

Thanks. Can you hear me okay, Jason?

Yes, I can, Paul.

So as much as I'd like to ask you yet again about how much of the weakness of supply chain versus demand, I will actually answer a different question. which is, interestingly, it hasn't come up, maybe not surprisingly, this quarter, but I've got to ask, in terms of the classic question of the risk of displacement for the cloud titans that the investment community has worried about for quite some time, and again, I recognize it's not perhaps the issue today, given the background, given the current macroeconomic environment, but any change in your thinking about the way you're positioned with Facebook and Microsoft in particular, with cloud titans in general, relative to that ongoing concern?

Okay, I'll try and answer the question. You're sounding very muffled, Paul. Maybe you're wearing a mask. But if I understood the question, what does the competitive landscape look like with Cloud Titans? And I would just sort of generically say that our fundamental thesis is unchanged. We're not seeing major competitive issues or architectural shifts. In fact, if you look at the recently released market data from both Deloro and Crehan, It validates our number one spot in 100 gig, and for the third consecutive year we are doing that. We are the number one market share in 100 gig. And we continue to increase market share into the high teens for high performance data center switching. So we are pleased with our progress year after year, including 2019. Anshul, I'd like to call you to see if there's any specific cloud pricing issues you want to highlight.

No, Jashree, and as we've said before, Paul, The level of joint development we continue to do with these customers, including Microsoft, is still pretty intense. So we're not overly worried. Yes, these are competitive environments. That will continue to be so. But there's no major shift.

Actually, Paul, this is a good time for me to highlight the work Anshul's been doing. As you know, we have a rich, long history in open networking. And today Arista just introduced a switch abstraction interface so that we can work with our best of the platforms and an abstraction layer for Cloud Titans who can now use Sonic on top of our Arista SAI. And this is another example of the close collaboration Anshul is mentioning.

If I could just follow up. I appreciate the market share comments, but obviously market share is the exactly looking phenomenon. And so with respect to forward looking and the risk of displacement, you all haven't seen or heard anything from those cloud titans that would cause you incremental concern relative to where you've been historically?

Yeah. On one hand, we are always paranoid and concerned. That's our nature, and we should be that way, and we want to continue to deliver the best of the best. On the other hand, we have no particular concern or no change in concern or no radical shift in the competitive landscape.

Thank you, Paul.

Thanks, Paul. Our next question comes from Ben Bolin with Cleveland Research. Your line is open.

Good evening. Thank you for taking the question. I was hoping you could step back a little bit and tell us your thoughts bigger picture about broader hyperscale investment. I'm not looking for guidance. I'm just interested how you think about these customers longer term. The framing for that, you know, near term, we're seeing these kind of material demand drivers, migration to SaaS, adoption of cloud, need for, you know, elastic capacity addition. And in the interim, not seeing a big change in those growth rates, the demand drivers themselves. So, I'm interested in how you think about it longer term. What are the material drivers that kind of accelerate growth rates? Any specific factors that you think could be, you know, meaningful for an acceleration in the broader investment? Thank you.

Thank you, Ben. Well, look, I think the greatest acceleration for Arista came when the Cloud Titans made a huge migration to a least fine architecture. and especially standardized on Arista's EOS for 100 gigabits universal spine. And then on top of that acceleration, a number of our titans co-developed with us a joint development focus that allowed them to scale this to distributed data centers all over the region and all over the cloud. So I think the next acceleration comes from more use cases, with 400 gig and 100 gig in tandem, with the possibility of expanding their data centers and their server density and their storage capabilities. And I don't think that's necessarily this year, but it could be in the next three years. So it would have to be a repeat of how we succeeded in 100 gig at 400 gig levels. Anshul, do you wanna add something more to that?

Yes, Ben, the way to look at the cloud, and the Cloud Titans is they started with data centers with compute and storage and then moved on to different types of apps and are continuing that journey. And the next phase of investment in this space, in our view, there will be more at the edge. By edge, I don't mean directly just edge computing, but think of it as an Equinix type of meet-me-place. So the cloud companies, I think, will continue to invest in that area. and then connect that back into the tenant space in their large data centers. And these networks of different kinds are being built or will continue to be built in the next few years with different types of overlays and encryption and mapping from one tenant space to the other and so on. I think that's very significant because in a longer picture, if you look at it five, ten years from now, we will look back and say, wow, this is how the cloud companies restitched the Internet. And I think those are some of the most strategic projects in the next few years.

Thanks, Anshul. That's great. The DCI and routing use cases cannot be underestimated. And they truly redefine the internet.

Thank you, Ben.

Our next question comes from with Bloomberg. Your line is open.

Oh, great. Thanks for squeezing me in. Long-term question as it relates to the enterprise. Has the nature of your conversations with your close enterprise customers changed at all? This may be a little bit premature. And the reason why I ask is, given that we're at a stay-at-home, zero-touch environment, one would have to think that the network automation thesis should start playing out a little bit faster, given that no one can get to their networks anymore. How does that fit into customer conversations today? Do you think that will evolve? And especially given that you do have Big Switch that provides that enterprise, hyperscale cloud-like environment to the enterprise, that might be a positive to you guys in the long term.

Yeah, no, Washington, you really bring up a good point here. We tend to talk about data center and campus and all of these different use cases, but our customers are thinking more and more operationally. It's great to have a box, but how to ignite that box with the right operational capabilities is very, very important. And so when you look at it, you're absolutely right. Day zero, day one, day two, zero touch automation, one click for the campus data center, huge topic. The other one, and this is why we bought Big Switch, is not only are we igniting real-time streaming telemetry and cloud vision, but we're really extending that into the observability and network packet broker space. And we're very pleased with the sort of sum of data analyzer, cloud vision, and now big switch to extend our dance monitoring fabric. So that trial or combination is going to be very important for deeper telemetry. So our enterprise conversations are going beyond best of breed platforms to much more operational automation, analytics, availability, and in the future, security and segmentation as well.

So just to follow on that, are these conversations that you've been having that's been ongoing for quite some time now, or does the, I guess, the pandemic crisis accelerate that and potentially force customers to make a left turn in their purchasing decisions or their architectural decisions causing purchasing delays?

Yeah. You know, I think it's too early to say it's because of the pandemic. They were going on anyway, but I think the importance of them becomes greater if the pandemic continues longer. Right now, I think we're getting more hammered on supply chain, but if we overcome that, I think we'll get much more on automation and analytics.

Okay, understood. Last question.

Thank you. Thank you. From Itai Kidron with Oppenheimer, your line is open.

Itai, are you back?

Yes.

Hard to get rid of me. Yes, of course. Again, just a couple, one for you, Jayshree, and one for you, Ida. Jayshree, do you get a sense of if there was any business activity in the quarter that was just a pull-in from second-half plans into the first half, given the effects of work from home that some customers saw pressures that they had to respond to quickly and did it by pulling in budgets? And for you, Ida, on the 2018 OPEX comments, I understand T&E you're clearly saving a lot of money there but are there headcount reductions planned as well or this is just less marketing less travel you know you're not flying business anymore how do I think about that yeah I mean I'll take that one first maybe just yeah no I think we are preserving kind of you know employee talent that's probably our you know our most important resource and we're definitely focused on

doing that. And really, we're looking at other areas, other more variable expenses, one-time type expenses that we can manage, you know, hopefully in a near-term window and preserve kind of employees and the talent base.

And the short answer tied to your question is we did not experience pull-ins in Q1.

Very good.

Good luck, ladies.

All right. Thank you.

Okay. This concludes the Arista Q1 2020 earnings call. We have posted a presentation which provides additional information on our fiscal results, which you can access on the investor section of our website. Thank you for joining us today, and please be safe, everybody.

Ladies and gentlemen, this concludes today's call. You may now disconnect.